Summary Table of Contents

Consistency and the Auditor's Report on Financial Statements

.01 This standard establishes requirements and provides direction for the auditor's evaluation of the consistency of the financial statements, including changes to previously issued financial statements, and the effect of that evaluation on the auditor's report on the financial statements.

.02 To identify consistency matters that might affect the report, the auditor should evaluate whether the comparability of the financial statements between periods has been materially affected by changes in accounting principles or by material adjustments to previously issued financial statements for the relevant periods.

.03 The periods covered in the auditor's evaluation of consistency depend on the periods covered by the auditor's report on the financial statements. When the auditor reports only on the current period, he or she should evaluate whether the current-period financial statements are consistent with those of the preceding period. When the auditor reports on two or more periods, he or she should evaluate consistency between such periods and the consistency of such periods with the period prior thereto if such prior period is presented with the financial statements being reported upon.1 The auditor also should evaluate whether the financial statements for periods described in this paragraph are consistent with previously issued financial statements for the respective periods.2

Note: The term "current period" means the most recent year, or period of less than one year, upon which the auditor is reporting.

.04 The auditor should recognize the following matters relating to the consistency of the company's financial statements in the auditor's report if those matters have a material effect on the financial statements:

A change in accounting principle

An adjustment to correct a misstatement in previously issued financial statements.

Change in Accounting Principle

.05 A change in accounting principle is a change from one generally accepted accounting principle to another generally accepted accounting principle when (1) there are two or more generally accepted accounting principles that apply, or when (2) the accounting principle formerly used is no longer generally accepted. A change in the method of applying an accounting principle also is considered a change in accounting principle.4

Note: A change from an accounting principle that is not generally accepted to one that is generally accepted is a correction of a misstatement.

.06 The auditor should evaluate and report on a change in accounting estimate effected by a change in accounting principle like other changes in accounting principle.5 In addition, the auditor should recognize a change in the reporting entity6 by including an explanatory paragraph, including an appropriate title, in the auditor's report, unless the change in reporting entity results from a transaction or event. A change in reporting entity that results from a transaction or event, such as the creation, cessation, or complete or partial purchase or disposition of a subsidiary or other business unit does not require recognition in the auditor's report.

.07 The auditor should evaluate a change in accounting principle to determine whether -

The company has justified that the alternative accounting principle is preferable.8

.08 A change in accounting principle that has a material effect on the financial statements should be recognized in the auditor's report on the audited financial statements. If the auditor concludes that the criteria in paragraph .07 have been met, the auditor should add an explanatory paragraph, including an appropriate title, to the auditor's report, as described in paragraphs .12–.15 of this standard. If those criteria are not met, the auditor should treat this accounting change as a departure from generally accepted accounting principles and, if the effect of the change in accounting principle is material, issue a qualified or an adverse opinion.8A

Note: If a company's financial statements contain an investment accounted for by the equity method, the auditor's evaluation of consistency should include consideration of the investee. If the investee makes a change in accounting principle that is material to the investing company's financial statements, the auditor should add an explanatory paragraph, including an appropriate title (immediately following the opinion paragraph), to the auditor's report, as described in paragraphs .12–.15.

Correction of a Material Misstatement in Previously Issued Financial Statements

.09 The correction of a material misstatement in previously issued financial statements should be recognized in the auditor's report on the audited financial statements through the addition of an explanatory paragraph, including an appropriate title, as described in paragraphs .16 and.17 of this standard.

.10 The accounting pronouncements generally require certain disclosures relating to restatements to correct misstatements in previously issued financial statements. If the financial statement disclosures are not adequate, the auditor should address the inadequacy of disclosure as described in paragraph .31 of AS 2810, Evaluating Audit Results, and AS 3105, Departures from Unqualified Opinions and Other Reporting Circumstances.

Change in Classification

.11 Changes in classification in previously issued financial statements do not require recognition in the auditor's report, unless the change represents the correction of a material misstatement or a change in accounting principle. Accordingly, the auditor should evaluate a material change in financial statement classification and the related disclosure to determine whether such a change also is a change in accounting principle or a correction of a material misstatement. For example, certain reclassifications in previously issued financial statements, such as reclassifications of debt from long-term to short-term or reclassifications of cash flows from the operating activities category to the financing activities category, might occur because those items were incorrectly classified in the previously issued financial statements. In such situations, the reclassification also is the correction of a misstatement. If the auditor determines that the reclassification is a change in accounting principle, he or she should address the matter as described in paragraphs .07, .08, and .12–.15. If the auditor determines that the reclassification is a correction of a material misstatement in previously issued financial statements, he or she should address the matter as described in paragraphs .09, .10, .16 and.17.

Reporting on Consistency of Financial Statements

Change in Accounting Principle

.12 A change in accounting principle that has a material effect on the financial statements should be recognized in the auditor's report on the audited financial statements through the addition of an explanatory paragraph, including an appropriate title (immediately following the opinion paragraph). The explanatory paragraph should include identification of the nature of the change and a reference to the note disclosure describing the change.

.13 The following is an example of an explanatory paragraph for a change in accounting principle resulting from the adoption of a new accounting pronouncement:

[Appropriate Title]

As discussed in Note X to the financial statements, the Company has changed its method of accounting for [describe accounting method changes] in [year(s) of financial statements that reflect the accounting method change] due to the adoption of [name of accounting pronouncement].

.14 The following is an example of an explanatory paragraph for a change in accounting principle other than a change due to the adoption of a new accounting pronouncement:

[Appropriate Title]

As discussed in Note X to the financial statements, the Company has elected to change its method of accounting for [describe accounting method changes] in [year(s) of financial statements that reflect the accounting method change].

.15 The explanatory paragraph relating to a change in accounting principle should be included in reports on financial statements in the year of the change and in subsequent years until the new accounting principle is applied in all periods presented. If the new accounting change is accounted for by retrospective application to the financial statements of all prior periods presented, the additional paragraph is needed only in the year of the change.

Correction of a Material Misstatement in Previously Issued Financial Statements

.16 Correction of a material misstatement in previously issued financial statements should be recognized in the auditor's report through the addition of an explanatory paragraph, including an appropriate title (immediately following the opinion paragraph).10The explanatory paragraph should include (1) a statement that the previously issued financial statements have been restated for the correction of a misstatement in the respective period and (2) a reference to the note disclosure describing the correction of the misstatement. The following is an example of an appropriate explanatory paragraph when there has been a correction of a material misstatement in previously issued financial statements:

[Appropriate Title]

As discussed in Note X to the financial statements, the 20X2 financial statements have been restated to correct a misstatement.

.17 This type of explanatory paragraph in the auditor's report should be included in reports on financial statements when the related financial statements are restated to correct the prior material misstatement. The paragraph need not be repeated in subsequent years.

Footnotes (AS 2820 - Evaluating Consistency of Financial Statements):

1 For example, assume that a company presents comparative financial statements covering three years and has a change in auditors. In the first year in which the successor auditor reports, the successor auditor evaluates consistency between the year on which he or she reports and the immediately preceding year. In the second year in which the successor auditor reports, the successor auditor would evaluate consistency between the two years on which he or she reports and between those years and the earliest year presented.

2 When a company uses retrospective application, as defined in Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections ("SFAS No. 154"), to account for a change in accounting principle, the financial statements presented generally will be consistent. However, the previous years' financial statements presented with the current year's financial statements will reflect the change in accounting principle and, therefore, will appear different from those previous years' financial statements on which the auditor previously reported. This standard clarifies that the auditor's evaluation of consistency should encompass previously issued financial statements for the relevant periods.

5SFAS No. 154, paragraph 2e, defines a "change in accounting estimate effected by a change in accounting principle" as "a change in accounting estimate that is inseparable from the effect of a related change in accounting principle."

6 "Change in reporting entity" is a change that results in financial statements that, in effect, are those of a different reporting entity. SeeSFAS No. 154, paragraph 2f.

7 Newly issued accounting pronouncements usually set forth the method of accounting for the effects of a change in accounting principle and the related disclosures. SFAS No. 154 sets forth the method of accounting for the change and the related disclosures when there are no specific requirements in the new accounting pronouncement.

8 The issuance of an accounting pronouncement that requires use of a new accounting principle, interprets an existing principle, expresses a preference for an accounting principle, or rejects a specific principle is sufficient justification for a change in accounting principle, as long as the change in accounting principle is made in accordance with the hierarchy of generally accepted accounting principles. SeeSFAS No. 154, paragraph 14.

8A AS 3105, Departures from Unqualified Opinions and Other Reporting Circumstances, describes reporting requirements related to a qualified or an adverse opinion.